Thursday, August 03, 2006

The best way forward is to put the force of competition to use in the labour market.

by Subir Gokarn

A set of proposals was jointly submitted to the government by Assocham and the CII last week, suggesting a series of initiatives to be taken by the business to increase economic opportunities for members of the scheduled castes and tribes. The proposals essentially involve interventions at all levels of the education system by way of setting up of coaching centres for preparation for admission to and endowment of scholarships at premier institutions. They also visualise mentoring programmes for the development of entrepreneurs from these communities.

These initiatives are all based on voluntary action by members of the two associations and compliance would be entirely self-regulatory. The associations propose a code of conduct, which would guide their members’ actions, reinforced by the regular disclosure by companies on their individual contributions.

The submission was, not surprisingly, categorical in its rejection of legally mandated job reservations in the private sector. A reaction to this by many people was that these proposals are a “too little, too late” reaction to the threat of mandatory quotas hanging over their heads. If this is all it takes to solve the problem, went the argument, why weren’t such initiatives taken sooner and voluntarily? Well, as any observer of reform processes would appreciate, positive change usually takes place when a crisis is imminent.

But, that is neither here nor there. Nobody would argue that these proposals are meant to be a solution to a problem that public policy has been unable to solve for six decades. It would be rather naïve to expect private solutions to address a problem of macroeconomic dimensions. The debate on this issue over the last few months has achieved at least two things.

One, it has focused attention on the scale of the problem, not just with respect to scheduled castes and tribes but other large segments of the workforce. Two, it has emphasised the fact that the constraints to change are complex enough to require the use of multiple instruments, exercised by both the government, through appropriate policy changes, and the private sector, through initiatives such as the ones proposed.

Whether these are sufficient or more is required is a question that cannot be answered in isolation. The respective roles and contribution of the public and private sectors have to be viewed from the perspective of inter-dependence and complementarity.

At the core of this complementarity is the labour market. Fifteen years after the reforms began, the benefits that reasonably well-regulated markets can bring are surely beyond question. The transition from public or licensed private monopolies to competitive supply has resulted in greater availability accompanied by lower prices in a whole range of sectors. Presumably, consumers of these products and services are better off than before, while efficient producers can earn reasonable profits even in such competitive situations. Why can’t the logic, as well as the experience, of product markets translate into sensible labour market policy, which should generate comparable outcomes in terms of larger volumes (employment) and benefits to “consumers” (employers) with reasonable returns to suppliers (workers)?

What does a competitive labour market mean? The most critical characteristic of competitive markets is the ease with which both consumers and producers can enter or exit. As cold as it may sound, this is best described by the term “hire and fire”. When job security regulations exist, an asymmetry is introduced between employers and workers. A worker is free to exit from a job, while an employer is not free to exit from his contract with a worker. This one distortion completely undermines the ability of the market to generate the positive outcomes listed above.

Restricting the freedom to exit significantly raises the cost of a worker as far as the employer is concerned. He has to continue to pay wages even when the worker is not contributing to revenues, for example, when the business faces recessionary conditions. The effective cost of a worker, therefore, is elevated significantly above his “wage”; the more turbulent the business environment, the larger this premium becomes.

The post-reform experience with employment can be viewed in this context. According to the data published by the ministry of labour, the private organised sector, in which job security regulations apply most stringently, saw its employment levels peak in 1998, with a persistent decline thereafter. Employment growth since the reforms has taken place predominantly in various service sectors, which are substantially exempt from job security regulations. A third fact, which is at the heart of the reservations debate, is that government and public sector employment has also been declining after attaining a peak in 1997.

The public sector, broadly speaking, was the vehicle of affirmative action in this country. Until 1990, reservations were the exclusive preserve of the scheduled castes and tribes, quotas for whom were enshrined in the Constitution. After that, the entitlement was extended to Other Backward Castes. However, in the years that followed, fiscal compulsions, the streamlining of government activities, and decline in investments by public enterprises led to fewer jobs being created in this sector, eventually resulting in net attrition since 1997. Quotas being applied on a smaller base obviously meant fewer job opportunities and, consequently, rising discontent.

It is tempting to look for a quick expansion of the base, to which reservations can be applied as a way of expanding employment opportunities for members of the target groups. But, as we have seen, the private sector is an entirely different kettle of fish; any restriction imposed on its conditions of employment tends to reduce its willingness to hire instead of increasing it. In effect, reservation will have an impact similar to job security regulations in raising the effective cost of each worker hired by hindering exit. The government could earlier afford to hire workers without considering their impact on the bottom line. Neither it nor the private sector can afford to do this today.

Under these circumstances, the best way forward is to put the force of competition to use in the labour market, just as we have so successfully done in the product and service markets. It is in this context that the associations’ proposals have to be viewed. Training, coaching, mentoring and other such initiatives are all useful ways of helping people exploit the opportunities that the marketplace creates—complements to the market mechanism. They are not substitute ways of creating those opportunities. This is one buck that the government just cannot pass on to the private sector.